Owner (K-1 partnership) -occ. refi, depreciation and debt/income

[Christoph Berendes]

My wife and I own a 3 unit apartment building as a partnership, shown on K-1 returns. We have lived in the top unit (#3) and rented out #1 and #2 for about 20 years. We'd like to refinance. (Note that the numbers below are fictitious, but resemble our situation. My question regards how the lender is calculating income in the debt-to-income ratio based on the existence of the partnership.)

If we treat the partnership as a standard business, our DTI is unfavorable:

• Net rental income: $7600
• Other income:        $3000
• Total:                   $10600
• Debt:                    $ 6000
• DTI: 57%

A DTI of 57% is above their limit.

However, since Net Rental Income excludes $1000 monthly depreciation (non-cash expense) and $2,400 interest expense (part of the proposed debt), we were initially told that they would add back depreciation and interest expense, leading to a monthly income of $14,000, and a debt-to-income ratio of 43%, and that DTI would pass muster.

The loan went to underwriting on that basis, but underwriting decided that they couldn't add back depreciation and interest expense, since it's a K-1. (They could, apparently, if we took the income on a schedule E, without a partnership.) So they've declined the loan.

The lender - Chase - says this is per federal guidelines. What other options should we consider?

Thanks.

[Andrew Postell]

@Christoph Berendes from here out you are never ever to apply for a loan on an investment property at a large, national, publicly traded bank ever again. I can't hold you to this of course but if you respond to me I'm taking it as a promise....NEVER EVER AGAIN.

As investors we have to work with smaller, local lenders.  The reason for this is that investment properties foreclose at a higher rate than primary homes...thus the higher rates on them.  And not only do banks know this...so do shareholders.  And shareholders have certain rights and they can actually control what banks do with their loans.  This might sound strange but this is exactly how it works.

So a smaller, privately held lender should be easier to work with for investors.  It's hard to guarantee this of course but it more likely to be the case.

So when we search for loans we need to know that there are 2 main types of loans for investors: “Conventional” and “Portfolio”

Conventional - I'll define these as loans that come from Fannie Mae and Freddie Mac (if you recognize those names). These loans are all 30 year fixed rate loans. They have the lowest rates we can find and since they are 30 year fixed...they allow us to cash flow better...which helps us qualify for other loans later. The draw back to these loans is that they are more paperwork heavy than the other "portfolio" types of loans...tax returns, etc....but if you have ever received a loan on your primary home, it's likely that you will go through the same type of paperwork here with conventional lending. Fannie/Freddie money = Fannie/Freddie rules. NOT the bank's own money.

Portfolio - I'll define these loans as loans that come from the bank's own "portfolio" of money. Sometimes referred to as "commercial" loans. These loans are a lot more flexible than "conventional" loans. Bank's money = Bank's rules. If they like you, then maybe they will lend to you. But since there is a limit to how much money the bank has access to....their rate will be higher...and usually a shorter term. The most common portfolio style loan in Texas is a 20 year adjustable rate loan. These loans are easier to get but the terms are different.

Fannie/Freddie types of loans will be available everywhere and those rules might change SLIGHTLY between lenders. Portfolio loans can run the gambit. Since each lender controls it’s own money you will have to call around to ALL the banks to learn about all the programs. A mortgage broker will help with this some…but even the best mortgage brokers don’t have access to ALL portfolio loans out there.

The point of all of this is you need to find a different lender.  And quiz them on the loan types they offer.  At the very minimum you should be able to get a porfolio/commercial style loan. Anyway, hope this helps in some way.